Gaming Guru

Gauging casino buyouts' role in misfortune

LAS VEGAS, Nevada -- Private equity firms made offers to acquire Harrah's Entertainment and Station Casinos in 2006 and early 2007, when capital was cheap and business was booming.

Their strategy was to boost the companies' value through job cuts and other cost reductions and take the companies public again after a few years at a large profit. The firms and their corporate targets touted it as a path to long-term profitability: Freed from Wall Street's quarterly profit treadmill, private companies can make decisions that sacrifice short-term profits but improve the company over the long haul.

Yet what's good for investors isn't always good for employees or the state, which is charged with fostering the gaming industry's long-term growth and health.

To critics, such deals, called leveraged buyouts, or LBOs, are the high-finance equivalent of flipping real estate — a shell game that succeeds more through questionable cost-cutting and layoffs than improved corporate management.

The deals didn't turn out as their architects had planned, because of the recession. Like over-mortgaged homeowners, the LBO targets, suddenly unable to pay down monster debts, became sitting ducks in the recession.

Station has asked bondholders to forgive millions in debt as part of an expedited bankruptcy proceeding. Though Harrah's hasn't missed any debt payments, it is asking bondholders to forgive debts as an alternative to filing for bankruptcy protection.

Although no exact figures are available, thousands of layoffs followed the Station and Harrah's buyouts. But there's disagreement over how many of those cuts were LBO-related and would have occurred regardless of the slump.

"Part of the game with these LBOs is that there were going to be bodies cut," said Joe Fath, a portfolio manager at T. Rowe Price Associates. (Like many investment firms, T. Rowe benefited from high prices private equity firms paid shareholders to take companies private.)

Fath, who questions the effectiveness of the deals, said he thinks cost-saving measures taken by Harrah's and Station were influenced by the LBO debt and not the recession alone.

Others note that gaming companies that weren't taken private, such as MGM Mirage and Las Vegas Sands, have slashed costs in a manner similar to Harrah's and Station.

About 14,000 fewer people were employed in gaming hotels in the Las Vegas Valley in May versus a year ago, according to state figures. The Culinary Union, which represents more than 50,000 casino workers on the Strip, has estimated that more than 5,000 people have either lost jobs or work reduced hours.

"Like most other private and public companies coping with the worst economic downturn the country has faced in decades, we're doing what's necessary to get through the current turmoil," Harrah's spokesman Gary Thompson said.

Executives with Station Casinos, citing the company's negotiations with bondholders and pending bankruptcy proceeding, declined to comment for this story.

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The argument that private equity firms better manage companies won over regulators, but it didn't appear to apply to Harrah's or Station, which were viewed as competently run companies before their LBOs. The companies weren't especially bloated and the same casino executives continued to manage them after the buyouts.

"Did these companies come in and make Harrah's and Station better companies? Not really," Fath said. "In the case of Harrah's, they have made things worse."

But Thompson said Harrah's has benefited from its private equity owners' "global expertise and contacts" in the travel, leisure and entertainment industries. The debate over whether leveraged buyouts strengthen or weaken companies has raged for decades, usually pitting labor unions against corporate interests.

Before the recession, LBOs were lucrative for both the shareholders who were bought out by private equity firms and the private equity investors who took them public again. To succeed, such deals require cheap capital and a booming economy — interest on the loans must be greatly offset by the company's ability to pay down the debt.

Harrah's buyout nearly doubled the company's debt, to more than $24 billion. Station increased its debt by more than 50 percent, to $5.7 billion.

Those debts were considered manageable when the economy, especially in Vegas, was flush.

The Private Equity Council, a trade group that represents LBO firms in Washington, D.C., cites studies showing that firms taken private have saved jobs, spurred employment and development while improving earnings performance.

Critics say that although some companies may be managed more efficiently under private management, others benefit merely from broader economic growth. These deals, they say, are nothing more than the product of upward business cycles.

The Government Accountability Office — in response to the little-regulated LBO boom and bust — released a report in September on private-equity-financed LBOs. The GAO, which cited evidence on both sides of the debate without drawing many definitive conclusions, said it's difficult to determine whether other factors unrelated to the LBOs improved performance. Likewise, factors beyond the deals themselves might explain the "lower employment growth" associated with some LBOs, the report said.

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LBO investors, who tend to own companies for three, five or even 10 years before selling them, have a longer-term outlook than many Wall Street investors. And yet, if their cost-saving strategy translates into less investment in resorts and other attractions, that makes their interests shorter-term than those of the state, which depends on casino industry growth spanning generations.

Station's reasons for going private weren't focused on cost cuts, according to an industry source familiar with the deals. The company wanted to be free to build attractions that might threaten profit in the short term, he said.

Harrah's decision not to redevelop its older west-facing Strip properties after going private was driven not by penny-pinching private equity firms but the realization that the return — with so much competition in the works — wouldn't justify the investment, said Thompson, the company spokesman.

"In light of what's happened with the economy and its impact in Las Vegas, I believe that was a prudent decision," he said.

Unlike Station, Harrah's was in cost-cutting mode at the time of the buyout offer. Harrah's began corporate-level layoffs in August 2006, Thompson said.

Harrah's has reduced staff to match business conditions, he said. "That said, we've built our business by focusing on customer service, and that remains our focus today."

The industry source said cutting labor costs makes sense for many LBOs but cautioned against it for labor-intensive casino companies.

Though lost business forced some cuts, "you can't cut your way to prosperity in a customer-service-oriented business," he said. "You have to grow your cash flow ... and you can't do that if you don't have enough bodies in your building."

Were the cuts more drastic for Station and Harrah's compared with their publicly traded peers? Would the companies have cut fewer employees had they not gone private?

With the depressed economy to blame for their balance sheets, it remains to be seen whether LBOs are bad for the gaming industry, said Bill Lerner, a principal with Union Gaming Group in Las Vegas.

"We'd know the answer to that question" if not for the economic turmoil, he said.

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